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Quantitative assessmentof a free trade agreementbetween MERCOSURand the European Union

Ivan Boyer

Andrs Schuschny

Statistics and Economic Projections Division

Natural Resources and Infrastructure Division

Santiago de Chile, Apri l 2010

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estudios estadsticos y prospectivos

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This document was prepared by Ivan Boyer ([email protected]) now staff member at the World Bank,during a traineeship at the Economic Commission for Latin America and the Caribbean (ECLAC), and AndrsSchuschny ([email protected]) now of the Natural Resources and Infrastructure Division of theCommission. The authors would like to thank Jos Durn Lima for his helpful comments during the preparationof this document.

The views expressed in this document, which has been reproduced without formal editing, are those of theauthors and do not necessarily reflect the views of the Organization.

United Nations Publication

ISSN printed version 1680-8770 ISSN online version 1680-8789ISBN: 978-92-1-121728-5LC/L.3158-PSales No.: E.09.II.G.131Copyright United Nations, April 2010. All rights reservedPrinted in United Nations, Santiago, Chile

Applications for the right to reproduce this work are welcomed and should be sent to the Secretary of the Publications Board,United Nations Headquarters, New York, N.Y. 10017, U.S.A. Member States and their governmental institutions mayreproduce this work without prior authorization, but are requested to mention the source and inform the United Nations ofsuch reproduction.

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CEPAL - Serie estudios estadsticos y prospectivos N o69 Quantitative assessment of a free trade agreement between

3

Index

Abstract ..................................................................................................... 7

Introduction .............................................................................................. 9

I. Recent trade trends between the two blocs

and the motivations to sign an agreement .................................... 111. Trade between MERCOSUR and the European Union ........... 112. Motivations venid establishing negotiations to sign a FTA

between both blocs ................................................................... 142.1 MERCOSURs motivations ............................................. 142.2 The European Unions incentives .................................... 142.3 Recent trade history between the EU and MERCOSUR.. 15

3. Literature review ...................................................................... 16

II. Methodology.................................................................................... 191. CGE modeling.......................................................................... 192. The GTAP Model..................................................................... 203. Regional and Commodity Aggregation.................................... 214. Benchmark equilibrium estimation .......................................... 225. Description of the simulations.................................................. 23

III. Results analysis ............................................................................... 251. Macroeconomic impacts........................................................... 26

1.1 Full liberazation scenario ................................................. 261.2 Comparison with the other scenario................................. 27

2. Impacts on regional trade ......................................................... 312.1 Full liberalization scenario............................................... 312.2 Comparison when sensitive products are excluded.......... 34

3. Impacts of the different simulations on economic sectors ....... 343.1 Effects on the different sectors production level ............ 34

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3.2 Effects on the different sectors exports.............................................................................. 383.3 Effects on the different sectors imports ............................................................................. 413.4 Effects on trade between MERCOSUR and the European Union by sector....................... 44

4. Evaluation of the trade structure, taking into account environmentally sensitive industries ...... 485. Welfare effects ............................................................................................................................ 49

5.1 Welfare effects of the FTA between MERCOSUR and the European Union..................... 49

5.2 Robustness of the effects on welfare................................................................................... 52IV. Conclusion ....................................................................................................................................... 55Bibliography............................................................................................................................................ 59Annexes .................................................................................................................................................... 63Serie estudios estadsticos y prospectivos: issues published................................................................ 73

Figures index

FIGURE 1 MERCOSUR: TRADE WITH THE EUROPEAN UNION (15), 1990-2006 ......................12FIGURE 2 MERCOSUR EXPORTS TO THE EU15 AS COMPARD TO EU15 EXPORTS

TO MERCOSUR, 2006 ........................................................................................................13FIGURE 3 PROCEDURE TO UPGRADE OF THE PROTECTION DATABASE

AND LIST OF THE CONSIDERED SIMULATED SCENARIOS ....................................23

FIGURE 4 MAIN MACROECONOMIC INDICATORS OF THE TWO SCENARIOS ...................... 29

Table index

TABLE 1 MERCOSUR: TRADE WITH THE EUROPEAN UNION (15), 1990-2006 ......................13TABLE 2 MACROECONOMIC IMPACTS OF THE FULL SCENARIO ......................................26

TABLE 3 MACROECONOMIC IMPACTS OF THE FULL LIBERALIZATION SCENARIOGDP DECOMPOSITIOS......................................................................................................28

TABLE 4 MACROECONOMIC IMPACTS OF THE SCENARIO THAT EXCLUDESSENSITIVE PRODUCT.......................................................................................................28

TABLE 5 EFFECTS ON GDP AND TRADE IN THE TWO SCENARIOS .......................................30TABLE 6 DISTRIBUTION OF EXPORTS BY TRADING PARTNER .............................................32TABLE 7 INTRA REGIONAL EXPORTS IN THE FULL SCENARIO .........................................33TABLE 8 INTRA REGIONAL EXPORTS VARIAATIONS IN THE FULL SCENARIO.............33

TABLE 9 INTRA REGIONAL EXPORTS IN THE SCENARIO INCLUDINGSENSITIVE PRODUCTS.....................................................................................................35

TABLE 10 PRODUCTION VALUE AT MARKET PRICES, BY SECTOR........................................35TABLE 11 DECOMPOSITION PRODUCTION VALUE BY SECTOR,

WITH DIFFERENT SIMULATIONS..................................................................................37

TABLE 12 EXPORTS BY SECTOR......................................................................................................39TABLE 13 DECOMPOSITION OF EXPORTS BY SECTOR, DIFFERENT SIMULATIONS ........... 40TABLE 14 IMPORTS BY SECTOR.......................................................................................................42TABLE 15 DECOMPOSITION OF IMPORTS BY SECTOR,

WITH DIFFERENT SIMULATIONS..................................................................................42

TABLE 16 TRADE STRUCTURE BETWEEN THE MERCOSUR AND THE EUROPEN UNION..44TABLE 17 TRADE BETWEEN MERCOSUR AND THE EU..............................................................45TABLE 18 TRADE BETWEEN ARGENTINA AND THE EU ............................................................46

TABLE 19 TRADE BETWEEN BRAZIL AND THE EU .....................................................................47TABLE 20 IMPACTS OF A FULL LIBERALIZATION ON MERCOSURS EXPORTS OF

ENVIRONMENTALLY SENSITIVE INDUSTRIES .........................................................49TABLE 21 IMPACTS ON WELFARE OF THE DIFFERENT SIMULATIONS..................................50TABLE 22 DECOMPOSITION OF THE WELFARE IMPACTS OF THE B2004+

AND FULL SCENARIOS ................................................................................................51

TABLE 23 SENTITIVITY ANALYSIS FOR WELFARE, FULL LIBERALIZATION SCENARIO ..53TABLE A.1 MAIN EXPORT PARTNERS, 2006 ....................................................................................64TABLE A.2 DETAIL OF PRODUCT AGGREGATION WITH GTAP 6.2............................................65TABLE A.3 DETAIL OF COUNTRY AGGREGATION WITH GTAP 6.2 ...........................................66

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TABLE A.4 LIST OF PREFERENTIAL AGREEMENTS CONSIDERED IN THE ALTERTAXSIMULATIONS UP TO DECEMBER 2001........................................................................67

TABLE A.5 LIST OF PREFERENTIAL ACREEMENTS CONSIDERED IN THESIMULATIONS TO DEFINE THE B2004+BENCHMARK SCENARIO .........................67

TABLE A.6 TARIFFS UPGRADED IN THE ALTERTAX SIMULATION ..........................................68

TABLE A.7 TARIFFS CHANGES SIMULATED IN THE B2004+BENCHMARK SCENARIO......... 69TABLE A.8 DETAIL OF SENSITIVE PRODUCTS...............................................................................70TABLE A.9 ENVIRONMENTALLY SENSITIVE INDUSTRIES .........................................................71

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Abstract

Using a GTAP CGE model/database, this paper assesses the possible effectsof a free trade agreement (FTA) between the MERCOSUR and the EuropeanUnion (EU). The study takes into consideration the most important recentfree trade agreements signed among the Latin American countries, as well asthe latest European Union enlargements. With a 2004+ benchmark basescenario where tariffs were updated by the addition of information on tradeagreements just signed by Latin American countries, two different policy

simulations are addressed: (i) full liberalization, (ii) liberalization excludingsensitive products. The global CGE model allows analyzing direct andindirect socio-economic impacts on subscriber countries as well as on othercountries in the region.

From the point of view of the MERCOSUR countries, the resultssuggest that the FTA would be beneficial to foster their exports, especiallyin the case ofLight manufactures. Imports to MERCOSUR from the EUwould be increased, particularly in heavy manufactures sectors. In termsof GDP the results remain positive in the case of all the MERCOSURcountries in all simulated scenarios. However, welfare implications areunevenly distributed in favor of all the MERCOSUR countries in thesimulated scenarios. The inclusion of sensitive products in the agreements

seems to reduce the magnitude of the results but does not change thedirection of the impacts. In any case, active public policies to mitigate thenegative effects on sectors, enhance positive impacts and seize dynamicopportunities towards sustainable development must be undertaken. Themain conclusion points out a potential complementary trade relationshipamong these two regions.

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Introduction

There is a shared consensus that free trade agreements (FTA) increase exportsand production levels in the short to medium term. However, this rise in exportsmight not lead to a subsequent increase in the product s level, so additional

policies could be useful to mitigate some possible negative effects to supportthe least competitive sectors, which are exposed a greater openness to theinternational competition.

In the short run, the net effect that will decide whether an FTA canbenefit to a country is the impact on welfare, which is a combination ofdifferent factors, including: (i) the countrys production specialization, (ii)winner and looser sectors, (iii) the distribution of added value amidst thedifferent sectors, (iv) the evolution of the terms of trade and prices, (v) thelevels of technology the sectors have and the qualification levels ofemployments, (vi) the evolution of tax revenues and their specific use.

Beyond gains in welfare coming from a better use of a countryscomparative advantage, a range of dynamic effects could also be the resultof liberalization, such as the ability to induce foreign direct investment,changes arising from a fluid access to high-tech capital goods and theincrease in domestic competition due to the greater openness. Theseeffects would increase countries benefits.

The main purpose of this paper is to analyse the direct and indirectimpacts of an FTA (free trade agreement) between MERCOSUR and theEU (European Union). MERCOSUR is a regional trade agreement

between Brazil, Argentina, Paraguay and Uruguay, created in 1991.Venezuela signed a membership agreement in 2006, but it has not yet

been ratified by the Brazilian and Paraguayan parliaments. In our study,we consider that Venezuela is not part of MERCOSUR. The aim of thisregional treaty is to support free trade and the free movement of goods,

people and currency. By European Union, we mean the 27 countrieswhich are linked by their belonging to the European Communities.

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The potential negotiation between the two regional blocs should be a result of a common expressionof interest materialized by previous inter-regional agreements, and the international trade context, as Dohamultilateral negotiations are frozen. The sluggish progress of multilateral discussions towards trade openinghas resulted in a wave of bilateral agreements worldwide. By 2006, the Latin American countries hadconcluded around 70 FTAs, with countries within and outside the region.

MERCOSUR and the EU signed an inter-regional cooperation agreement in Madrid in 1995, which

came into effect in 1999. The negotiations for an FTA started in 2000. In 2004, an offer detailing tariffmodifications for each product line was made by both blocs, but was finally rejected. MERCOSUR did notaccept the EU proposal on agricultural issues, whereas the EU was mainly concerned by the conditions onservices and public markets access.

During a negotiation process, indigenous groups, famlily farmers, small-producer organizations,trade unions and many social movements use to move in order to halt the progress of process. Thenegotiations are viewed as a concession to economic and geopolitical interests. This is why we feel thatit is appropriate to conduct as objective as possible a quantitative evaluation of the consequences of anagreement for the MERCOSUR and the EU. This study therefore analyses the macroeconomic andsectoral effects (GDP, exports, imports and intraregional trade), as well as their impact in terms ofwelfare. It uses the database of the Global Trade Analysis Project (GTAP version 6.2) and its computablegeneral equilibrium (CGE) model. As the base year for the GTAP database version is 2001, the tariff data

were updated to 2004 (+ other recent agreements) so as to take into account all the preferential agreementsand tariff reductions in force in the region as well as the recent enlargement of the European Union.

It is important to note that, as with any application of the computable general equilibrium model,the simulation exercises in this study do not consider the possible effects of non-commercial aspects of afree trade agreement (such as investments, public procurement, intellectual property, infrastruture needsor competition policy), which for some countries are even more important than the merely commercialaspects. Furthermore, as they are static simulation exercises, their added value lies in identifyingwinner and loser sectors, regions and agents. These are therefore short to medium term results thatdo not allow growth paths to be deduced nor possible dynamic effects to be incorporated. Even thoughthe model tries to reflect the system of prices and quantities, as well as the public policies applied (inthis case free trade agreements), it does not incorporate the institutional, administrative, business,cultural and other elements that are also key to exploit the static and dynamic advantages of a trade

agreement and to mitigate adverse effects. Although these limitations do not invalidate the results, theydo limit the scope of interpretation and call for caution in the use of the model.

We will consider two scenarios. In the first one, MERCOSURs countries and the EU fully liberalizetheir bilateral trade (Full) by removing tariff barriers of all products. Then, one alternative scenario issimulated, which excludes sensitive products (excluding sensitives).

Section 1 describes the trade relations between MERCOSUR and the EU putting focus on the reasons fornegotiating and the recent trade relations between them. Section II describes the model, the country and productaggregations and the simulation scenarios. Section III details the main results. Section IV concludes the studyand brings in some insight about the key outcomes and recommendations.

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I. Recent trade trends betweenthe two blocs and the motivationsto sign an agreement

1. Trade between MERCOSUR and theEuropean Union

According to the UN Comtrade database information, the European Union(EU) is MERCOSURs1main trading partner. In 2006, the EU152accountedfor 20.1% of MERCOSUR total exports, and 18.9% of MERCOSUR totalimports came from the EU15 (See Appendix 1). On the other side, the EU15trade is dominated by intra-regional exchanges, as 59% of its exports wereintra-bloc trade.

Even though it was criticized by various sectors, many analysts haveconsidered that a free trade agreement (FTA) among both blocs couldincrease their mutual trade with a positive effect on the overall economicactivity. Note that in 2006, MERCOSUR only represented 0.6% of EU15total exports and 0.9% of its total imports. However, since 2004, theMERCOSUR biggest countries in terms of production, i.e Brazil andArgentina, encompass a positive trade balance with respect to the EU15.

1 MERCOSUR is the Regional Trade Agreement among Brazil, Argentina, Uruguay and Paraguay, founded in 1991 by the Treaty of

Asuncin which was later amended and updated by the 1994 Treaty of Ouro Preto. Its purpose is to promote free trade and the fluid

movement of goods, people, and currency.2 The European Union (EU) is a political and economic union. It was established by the Maastricht Treaty in 1993 upon the foundations of the

pre-existing European Community. The EU has developed a single market through a standardised system of laws which apply in all member

states, guaranteeing the freedom of movement of people, goods, services and capital. We refer EU15 to the 15 countries of the European

Union before the expansion on 1 May 2004. These countries are Austria, Belgium, Denmark, Finland, France, Germany, Greece, Republic of

Ireland, Italy, Luxembourg, Netherlands, Portugal, Spain, Sweden and the United Kingdom.

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This is also the case for Uruguay, whereas Paraguay, the smallest economy, has had a negativetrade balance with the EU15 for the last 12 years.

Commodities and natural-resource-based manufactures accounted for 73% of MERCOSURexports to the EU15 during 2006, whereas medium and high-technology manufactures represented 70%of EU15 exports to MERCOSUR (see Figure 1 and Table 1). The main EU exports to MERCOSUR areconcentrated in transport equipment, machinery and chemicals, whereas MERCOSUR mainly exports

Agricultural productsto the EU, more particularly crops, grains, processed food (Figure 2 and Table 1).

From an historical point of view, MERCOSUR exports to the EU15 grew 91% since 2000. Thisincrease represents 17.2% of the total growth of MERCOSUR total exports since 2000. It is expectedthat a FTA between both blocs could maintain this trade growth trend. It is important to point out thatalthough MERCOSUR is supposed to be a Custom Union facing unified tariffs lines, the EU still facesdifferent tariffs from each of the four MERCOSUR countries for some products.

FIGURE 1

MERCOSUR: TRADE WITH THE EUROPEAN UNION (15), 1990-2006

(Millions dollars)

Argent ina

-4 000

-2 000

0

2 000

4 000

6 000

8 000

10 000

1990 1995 2000 2004 2005 2006

Exports Impor ts Trade Ba lance

Brazil

-5 000

0

5 000

10 000

15 000

20 000

25 000

30 000

35 000

1990 1995 2000 2004 2005 2006

Exports Imports Trade Balance

Paraguay

-300

-200

-100

0

100

200

300

400

1990 1995 2000 2004 2005 2006

Expor ts Imports Trade Balance

Uruguay

-400

-200

0

200

400

600

800

1990 1995 2000 2004 2005 2006

Expor ts Imports Trade Balance

Source: ECLAC, Division of International Trade and Integration, on the basis of official figures from the United NationsCommodity Trade Statistics Database (UN Comtrade), DESA/UNSD.

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FIGURE 2

MERCOSUR EXPORTS TO THE EU15 AS COMPARED TO EU15 EXPORTS TO MERCOSUR, 2006

(Millions of dollars)

0%

20%

40%

60%

80%

100%

Argentina Bras il Uruguay Paraguay Mercosur EU15

Comm odities Natural-resource-based m anufactures

Low-tech manufactures Medium-tech manufactures

High-tech manufactures

Source: ECLAC, Division of International Trade and Integration, on the basis of officialfigures from the United Nations Commodity Trade Statistics Database (UNComtrade), DESA/UNSD.

TABLE 1

MERCOSUR: TRADE WITH THE EUROPEAN UNION (15), 2006

(Millions of dollars)

Trade balance detailed by technological intensity

Countries X M X-MCommodities

Natural-resources-

basedmanuf.

Low-techmanuf.

Medium-tech

manuf.

High-tech

manuf.Others

Argentina 7 798 5 576 2 222 5 510 284 -194 -2 098 -1 222 -59

Brasil 29 573 19 412 10 161 12 633 3 455 890 -4 201 -2 628 13

Uruguay 659 469 190 386 5 105 -234 -71 -1

Paraguay 113 323 -210 55 -37 -24 -147 -50 -8

Source: ECLAC, Division of International Trade and Integration, on the basis of official figures from the United NationsCommodity Trade Statistics Database (UN Comtrade), DESA/UNSD.

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2. Motivations behind establishing negotiations to sign a FTAbetween both blocs

In this section we point up the main motivations from both blocs to sign a FTA.

2.1 MERCOSURs mot ivations

There are several factors, which can explain the possible MERCOSURs motivation to sign anagreement with the EU:

The limited size of the regional market. If an agreement is signed, it would become the largestfree trade area in the world, including a population of more than 650 million people.

The weakness of the regional integration. The negotiations with the EU would leverageMERCOSUR to talk as a single voice. The perspective of an agreement would increase theinternational influence of MERCOSUR and its worldwide integration.

The skepticism concerning the WTO multilateral negotiation combined with the need to havestable and predictable trading relationship with its trading partners (remember the recent

unsuccessful DOHA round discussions).

The optimistic expectations of long term gains, such as the increase of FDI and productivityimprovements resulting from liberalization by means of an increase in the capital stock as wellas technological transfers.

There are numerous non-tariff barriers which hinder the imports of agricultural products inEurope such as theanti-dumping and phytosanitary measures from the Common agricultural

policy (CAP) and other rules of origin, for example. An agreement could improveMERCOSURs access to the EU agricultural market.

An agreement could reinforce MERCOSURs negotiation position in the US trade liberalizationinitiatives as well as in the WTO multilateral process. Parallel talks tend to put pressure with theaim to obtain better concessions (Bulmer-Thomas, 2000).

An agreement would be a further incentive to integrate MERCOSUR products in globalproduction networks.

On the other hand, there would also be some possible negative impacts which, in the case of aFTA implementation, should be mitigated by other policies. We show details about them in theconcluding remarks section of this study.

2.2 The European Unions incentives

For the EU, the relevance of an agreement with MERCOSUR is both economic as well as strategic. Asexplained in Doctor (2005), the EU wants to export its institutional and economic model, to promote itsvalues, principles and norms definition and to ensure part of the market if the FTAA is concluded. An

agreement can also be seen as a means to put the pressure on the European States to accept the Commonagricultural policy (CAP) reform. MERCOSURs main competitive advantage lies in exports of foodand processed food, and lower EU agricultural tariffs would certainly lead to a rise in MERCOSURsexports to the EU, thus pressing the primary sector to further reform so as to cope with an increasedcompetition.

Santander (2005) underlines that the EU has a strategy for the entire LAC region only since the90s. This strategy was brought about by the new international context, with the end of the Cold War,the emergence of regional powers, the debate on the US decline and the rise of the Indian and Chineseinfluence. One of the main objectives of what has been defined as a kind of new regionalism(Marchand et al., 1999) was to enable the EU to export its governance principles and norms and to

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increase its reputation as a relevant international actor. Some political topics were included in theagreements, such as democratization, human rights, labor and environmental standards. The firstagreements between the EU and the MERCOSUR have included inventive sections such as democratic

principles and future developments with the purpose of allowing negotiating further than the meretrade talks.

Ladi (2005) interestingly addresses the European preference for norms. The author explains that

the EU is still a soft power. It has not the characteristics of a hard power (the capacity to usestrength, to raise apprehension) because the Europeans do not see themselves as the ultimate warrants oftheir security. Thus, the EU tries to convince others to accept its own preferences. Through agreements(such as the one we have studied in this paper) and conventions, it aims at producing norms to organizethe world, determining the rules of the game, introducing predictability in economic as well as political

behaviours. These norms for Europe comprise the implementation and strengthening of democracy,market economy, the rule of law, human rights, social justice and environmental deference. This

preference for norms finds its origins in the internal functioning of the EU, which is always oscillatingbetween States sovereignty and elements of supra-nationality. Norms allow Europe to overcome Statessovereignty without abolishing it.

Trade openness is vital for Europe, as it is the world first exporter and second investor. The EUalso attempts to improve its competitive advantage in services, which represent two thirds of European

GDP and employment, but only 20% of world trade. It has thus an interest in strengthening servicesliberalization. Moreover, signing bilateral agreements is important for the EU so as to protect its socialmodel. Emerging countries often have social and environmental norms not as developed as in the EU,and the purpose of Europe is to attempt to organize trade relations, ensure a transparent access tomarkets, guarantee protections against corruption, protect intellectual property rights and integrateenvironmental constraints and fair labor rules.

Another motivation to negotiate an agreement has been a response to the US aspirations in theregion, symbolized by the FTAA process and the subsequent set of bilateral agreements that the UShave signed with several Latin American countries.

The influence of multilateral talks can also be highlighted. The failure of WTO talks at Cancun in2003 certainly was an incentive for the EU and the US to try to sign bilateral agreements. For instance, the

US signed the DR-CAFTA (Domenican Republic and Central America Free Trade Agreement), and therecent bilateral agreements with Colombia and Peru to strengthen the FTAA process. The EuropeanCommission tried to sign an agreement before the Commission change in 2004. Such an agreement wouldalso have facilitated the relations with the G20 at the multilateral level. It is relevant to adrress thatnowadays the EU is also negotiating a posible FTA with the countries members of the Andean Community.

2.3 Recent trade history between the EU and MERCOSUR

This section analyzes why negotiations have failed so far, and what is the chance for such an agreementto be signed.

Since the creation of the MERCOSUR in 1991, the European Union (EU) has maintained a closerelation with the regional bloc. In 1992, the MERCOSUR and the EU signed an inter-institutionalagreement, and then an inter-regional cooperation agreement in Madrid in 1995. The latter came into

effect in 1999, and considers several issues such as: political dialogue, cultural cooperation,communication and economic and trade cooperation. The purpose of this agreement was to prepare thenegotiations for an inter-regional integration agreement including trade liberalization. The negotiationsfor a FTA started in 2000, and were halted in 2004, in spite of offers from both sides. The MERCOSURoffer encompassed the liberalization of 89% of tariff positions within twelve years, whereas the EUoffer included 93% of positions within ten years.3

3 See Trade Sustainable Impact Assessment of the Association Agreement under negotiation between the European Community and

MERCOSUR, June, 2007.

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The main reasons to discontinue the negotiations were an impossibility to agree on agricultureissues, and the European critics on MERCOSURs proposal on services and public markets. Moreover,many of the topics under consideration were also part of WTO talks (Doctor, 2005). Among otherfactors which motivate negotiations, were also the EU enlargements, the failure of WTO and FTAAtalks (Doctor, 2007). Another problem was the weak MERCOSURs integration: there was no Commonexternal tariff for products like computers, telecoms, capital goods and trade remained administrated in

the case of cars and transport equipment.Finally, stakeholders from the civil society were not convinced that potential losers would be

compensated. Given its political influence, the worries of the European agricultural sector to experiencehigh losses had an influence in decreasing the EU motivations.

The question that may come to mind is if there is still a possibility for this agreement to come intoforce. According to the MERCOSUR Chair of Sciences-Po, Paris, the MERCOSUR integration has

been slowed and makes an agreement less attractive for the EU. There has been a lack of motivationthan in previous negotiations. The inclusion of other topics such as immigration, infrastructure andenergy or international cooperation could help advancing more quickly. Moreover, it is important tounderline that all FTA signed by the MERCOSUR since 1995 have been with Southern countries(Vaillant 2005, 2006).

On the other side, an agreement could induce WTO talks on agriculture, as it would be showed asan achievement of important negotiations between emerging and developed countries on that topic.Some European industrial sectors are highly interested by a possible agreement, in particular in theenergy, telecommunications and banking sectors. (Chaire MERCOSUR 2004). Another important factoris also the Brazilian will to strengthen its regional and international position.

The end of negotiations was not enough to definitively burry the hopes for the signature of anagreement. Doctor (2007) underscores that Interestingly, although, on the one hand, the EU wasexpected to gain more in concrete terms as a result of trade and investment liberalization, the inter-

regional project as such was expected to change very little in the EU. On the other hand, while

MERCOSUR was expected to gain relatively less (especially in terms of more exports), the inter-

regionalism project could work wonders for the consolidation of MERCOSUR and the economic

reforms undertaken in the region. It would also benefit along the lines of Lamys ideal, where economic

governance contributed to enhancing citizens quality of life. Thus, the cumulative impact of such an

agreement could actually transform the growth and development of the region. Finally, it is also worth

pointing out that should multilateral talks fail, inter-regionalism, by default, might become the only

viable option for expanding trade and securing investment.

3. Literature review

The following section describes the main results obtained in the literature concerning: (i) the possible andrealistic impacts of Doha trade talks and (ii) the effects of an FTA between MERCOSUR and the EU.

It is widely recognized that multilateral agreements would have more positive effects thanregional ones, because it would create less distortions, it would grant access to every country and allowmore balanced and open talks. However, regional or bilateral agreements can be favored by countries

when the multilateral talks are halted, as it is the case at the present time.

As noted in Vyborny (2006), plausible scenarios which provide a realistic outcome of Doha talksinclude the studies by the World Bank (2006), IFPRI (2006), CEPII (2006), and Carnegie Endowmentfor International Peace (2006). These references use models that estimate the global Doha welfare gainsto be between $32 billion and $55 billion. Estimations vary from one study to another because ofdifferent assumptions about the models and the Doha rounds possible conclusion. For example, theauthors use different trade elasticities of substitution.

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These outcomes are much smaller than those from earlier studies, which included outdated tradedata that overstated the gains. For instance, earlier models did not include existing trade preference

programs for developing countries. The simulations use to show that high-income countries are thosewho would benefit the most from the liberalization, followed by middle-income countries (whichinclude MERCOSUR countries). Low-income countries would receive a smaller share of global gains.In the most realistic scenarios, most of the gains come from manufactures liberalization.

Other studies try to assess the possible impacts of bilateral or regional FTAs, including somepapers on the agreement between MERCOSUR and the EU, as follows:

Calfat and Flores (2004) have concentrated on the liberalization of the trade in goods. Based ontrade flows statistics, they select products for which prospective gains lie within the agreement. For eachidentified product, they produce a US dollar value that predicts the market access gains. This valueresults from adding up trade creation and trade diversion. They examine two scenarios: (i) a reduction of50 % in the ad valoremtariff equivalent and (ii) a similar reduction of 100 %. They find that the sum ofall gains under total liberalization amounts to $1,45 billion for MERCOSUR, and $1,2 billion for theEU. The first three top goods for MERCOSUR orange juice, bovine cuts boneless, fresh or chilled andfrozen account for a little more than 50 % of the total. It represents around 8 % of annual exports;which is quite attractive for a preferential agreement. A fifty percent reduction in the tariffs results in afigure of $0,74 billion gains for MERCOSUR ($0,61 billion for the EU).

The Trade SIA (sustainability impact assessment) of the Association Agreement undernegotiation between the European Community and MERCOSUR (2008) is a large scope study, whichcombines CGE and econometrical analyses. It has been commissioned by the European Commission,which negotiates trade agreements on behalf of EU countries. It investigates the impacts of an FTA foragriculture, industry and services and rules related measures (including investments, trade facilitationand government procurement). The impact of static gains under full liberalization on EUs GDP wouldreach 0,1%. Static gains in GDP for MERCOSUR would be 0,5% for Argentina, 1,5% for Brasil, 2,1%for Uruguay and 10% for Paraguay. Most of these gains stem from manufactures liberalization, fewfrom services. MERCOSUR would have its agriculture production increased, whereas its manufactures

production would decline. Welfare gain for the MERCOSUR would account for $9 billion, and $4billion for the EU.

Monteagudo, Watanuki (2003) compare the impact on MERCOSUR of a FTA with the EU and ofa free trade area in the Americas. They find economic gains for MERCOSUR in both cases, althoughsomewhat higher in the case of an FTA with the EU. They use a multi-country, multi-sector, andcomparative static CGE model benchmarked in 1997. They assume that all trade barriers are completelyremoved. They find a 2,95% static impact on MERCOSURs real GDP (3,16% for Brazil and 2,43% forArgentina). MERCOSURs exports would grow 7,9%, and its imports 6,4%. The sectors that display themost dynamic export growth are meat products, growing by more than 30% above the average inArgentina, and grains which increase approximately 40% greater than the average in Brazil. In Brazil,exports of meat products also develop 20% above the average. The FTA reinforces MERCOSURsspecialization in processed foods exports.

Franois, J., McQueen, M, Wignaraja, G. (2005) build their quantitative analysis around theGlobal Trade Analysis Project (GTAP) computable general equilibrium model and database (version5.0) with an aggregation of 29 regions and 24 sectors It presents a simulation of the effects of fiveEuropean Uniondeveloping partner FTAs (South Africa, Mexico, Chile, MERCOSUR and Egypt) andthe customs union agreement in industrial products with Turkey. The global impact of the EU-MERCOSUR regional agreement on real income would amount to $2,3 billion for MERCOSUR and$3,95 billion for the EU.

Flores and Watanuki (2008) use the static CGE model known as AMIDA Analysing MercosursIntegration Decisions and Agrements to study impacts of possible FTAs between Mercosur and itsmain trading partners. The model introduces economies of scale and imperfect competition in somesectors. It includes 25 sectors and 10 regions, and is benchmarked in 2001. They find relatively small

but positive gains in case of a full liberalization with the EU. Mercosur would sharply reorient its

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exports towards the EU, while increasing its imports from most other markets. Mercosurs agribusinessexports would be the most favorably affected, with a 62% increase. The rise in exports to the EU markettakes place at the expense of generalised decreases in all other regions. On the other hand, importsincrease almost everywhere. According with this study, the FTA with the EU favours demand for moretraditional exports in which MERCOSUR has competitive advantages. At sectoral level, traditional

products such as textiles and apparel, leather, wood and papers with expand exports to the EU, but the

agreement induces a contraction on the sectors of heavy manufactures such as motor vehicles, othertransport equipment and machinery.

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II. Methodology

It is not easy to estimate ex-ante the impacts of a trade agreement, sincemany factors and conditions are involved. The expected impacts of anagreement between MERCOSUR and the EU will mainly depend on thestatic reallocation effects of productive factors as well as the dynamiceffects resulting from the expected increase in competition within theintegrated market, the potential investments flows and the technologytransfers, among others. Moreover, complementary economic policies

connected with FTAs can also have important consequences (e.g.development cooperation and agreement-pushed domestic reforms,stabilization policies and so on).

1. CGE modeling

Since the implementation of several FTAs in the early 1990s, applied CGEmodeling has become one of the most important empirical tool to assesstheir impacts. Because of its systemic nature, the extensive economy-wideeffects expected from policy shocks associated with trade openness requirethe use of general equilibrium analysis as one of the main used quantitativetools. Moreover, theoretical models and databases have been undertaking

continual improvements over the recent years to match the broad use thatCGE models have experienced.

Applied Computable General Equilibrium (CGE) models arenumerical representations based on the neoclassical General EquilibriumTheory. The central idea behind the CGE models is turning the abstractrepresentation of the Walrasian economic theory into a practical quantitativetool for ex-ante policy analysis and applied economic research.

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CGE models are multisectoral, and in many cases, such as the model used in this study, they aremultiregional. The behavior of economic agents is modeled explicitly throughout utility and profitmaximizing behavior assumptions that capture the most important interdependences among differentsectors of the economy and also with other related economies or countries. Economy-wide resources and

budget constraints are rigorously enforced and, as a consequence, alterations in the economic systemswill often have impacts beyond the sector in which they occur. This is the key difference between CGE

representations and the traditional partial equilibrium models. Thus, simulations of CGE models areeffective to capture the relevant direct and indirect effects of changes in trade policy as well as othertype of shocks, because the outcomes of the policy interventions can be quantitatively examined withina consistent framework that takes into account the overall relevant market interrelationships.

2. The GTAP Model

The Global Trade Analysis Project (GTAP) is an international community network of establishedinstitutions and researchers that makes possible and promotes trade policy analysis by means of a fluidexchange of useful information and modeling frameworks. The most important aim of the project is to

provide updated datasets of bilateral trade, import protection and transport data, substitution elasticitiesand other behavioral parameters, in combination with individual country based input-output databases

which take account of the productive structure of the represented countries. The Project also provides amodeling framework, the GTAP model (Hertel, T. (1997) and Schuschny, Durn & de Miguel, (2006)),to conduct CGE static analysis of multi-region and economy-wide scenarios. It is internationallyrecognized and widely used, particularly for the study of problems linked to international trade at aglobal level. It is important to underline that the GTAP project is coordinated by a consortium ofinternational and national institutions, among which the World Bank (WB), the Inter-AmericanDevelopment Bank (IDB), the Asian Development Bank (ADB), the World Trade Organization (WTO),the United Nations Conference on Trade and Development (UNCTAD), the International Food PolicyResearch Institute (IFPRI), the Environment Directorate of the OECD, the United Nations EconomicCommission for Africa (UNECA), the European Commission (EU) and the Centre dEtudesProspectives et dInformation Internationales (CEPII), etc.

The GTAP model of global trade is a standard, multi-region, applied general equilibrium model

that assumes constant returns to scale and perfect competition in production activities. This model isable to simulate the effects of trade policy interventions by means of a set of specific shocks which,affecting the comparative static equilibrium, ensue on a new equilibrium state which represents themedium-term pattern of the global production and trade creation and erosion.

The standard GTAP model uses a regional representative household simulated by a Cobb-Douglas function to assign constant expenditure shares to private consumption, public expenditure andsavings. This representation allows us to perform an unambiguous indicator of welfare offered by theregional utility function, which accounts for the three sources of utility. Private household behavior ismodeled by means of a Stone-Geary utility function where all subsistence shares are equal to zero. Thisspecification allows for a well-defined intertemporal maximization between consumption and savings.

Firm behavior is modeled using a technology tree that depends mainly on the assumptions ofseparability in production. Decisions are being made at each level, without considering the variables at

other levels. It is assumed that firms first choose between primary factors independently of the prices ofintermediate inputs. In addition, constant returns to scale are also assumed. The combination of primaryfactors and intermediate inputs is assigned using a Leontief function. The model assumes that there isimperfect factor mobility, which is described with CET income functions. The design of the simulationsassumes that there is full employment, although the use of slack variables allows the introduction ofsome sort of flexibility with regard to this assumption. The combination of intermediate domestic andforeign inputs is selected by means of CES (Constant Elasticity of Substitution) functions, the selectionamong foreign inputs is based on an Armington specification within CES functions and, finally, the mix

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of factors is assigned also with CES functions. All the elasticities of substitution are held constantduring the simulations.4

Aggregate investment is not explained within the standard GTAP model, because it doesnt takeinto account macroeconomic policies and monetary phenomena. In the GTAP model, investmentfollows the saving adjustment. Accordingly, the macroeconomic closure employed is the standard neo-classical and investment is enforced to adjust in line with regional changes in saving levels. In addition,

a global closure is assumed and the current account deficits can be non-zero but they must be balancedin the global bank, where trade deficits must be compensated among regions.

The simulations are based on perfect competition (which implicates that firms have no benefits) andconstant returns to scale hypotheses. Impecfect competition models used to record less volatile changesthan in full perfect equilibrium execises and should be considered for a more detailed realistic analysis.

The model simulations are numerically implemented using the GEMPACK (General EquilibriumModeling Package) software, developed by the Center for Political Studies of Monash University(Harrison and Pearson, 1996). We have used the Gragg extrapolation solution method, which allows usto deal with a significant list of shocks that are induced by the trade liberalization agreements consideredin the study. Details of the model implementation can be seen in Hertel, T. (1997). A spanish review ofthe model can be see in Schuschny, Durn & de Miguel (2006). It is important to note that the

simulation results include the full adjustment of the economy to the policy intervention shock and thus,can represent the medium-run effect of the considered FTA.

Before analyzing the results, it is also important to keep in mind that we are first using a staticGTAP application that does not take into consideration the possible increases in foreign directinvestment to the signing MERCOSURs countries, as a response to the incentives provided by the

bilateral liberalization.

3. Regional and Commodity Aggregation

The GTAP model cannot be thought separated from its database. The information available in thisintegrated GTAP database is used to calibrate the reference equilibrium and to set-up the behavioralequations and market clearing balances in order to carry out the required simulations. We have used theGTAP database version 6.2, which considers the year 2001 as its baseline. The GTAP databasedistinguished between 92 regions and 57 commodity groups that must be aggregated according to theanalysts interests with the purpose of making the model computationally tractable (see Dimaranan andMcDougall, 2005). Appendix 2 and 3, respectively shows the product and regional aggregations used inthe experiments considered in this article. The 57 commodities distinguished in GTAP 6.2 databasewere grouped into 33 aggregates (added also in five consolidated groups), which were selected by theirimportance in terms of trade flows, considering the relevant exporting and importing sectors for theLAC region and bearing in mind the convenience of disaggregating both agricultural products andmanufactures (see Appendix 2). Because, the Economic Commission for the Latin America and theCaribbean (ECLAC-UN) is interested on the overall Latin American and Caribbean (LAC) regionalimpacts of trade policy interventions, the most important criterion to establish this countriesaggregation (21 regions) is based on the selection of all LAC available countries as well as those other

countries that are either their largest trade partners or main actors in the international trade (seeAppendix 3).

4 A Systematic Sensitivity Analysis (SSA) was done over these elasticities because they are the most relevant parameters in connection

with trade effects and terms of trade variability.

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4. Benchmark equilibrium estimation

The GTAP 6.2 database uses 2001 as its reference year. The year 2001 cannot provide a good basis toanalyze the FTA between MERCOSUR and the EU since lots of agreements were signed in the LatinAmerican region between 2001 and 2004 plus other recent agreements such as the DR-CAFTA and the

EU enlargement. During this period of time, Chile signed various agreements, in particular with theUSA, the European Union and South Korea, and improved its preferential access with MERCOSUR andthe Andean Community. The ALADI (Latin American integration association) members also extendedtheir mutual preferential access, and the CAFTA-DR (Dominican Republic-Central America Free TradeAgreement) was signed on August 5th, 2004. Besides, on December 4th, 2001 expired the Andean TradePreference Act (ATPA), which had been signed by the USA for the unilateral benefit of Colombia,Bolivia and, afterwards, Ecuador and Peru. This treaty were expanded from 2002 to June 31st, 2007 viathe promulgation of the Andean Trade Promotion and Drug Eradication Act (ATPDEA). In addition, theEuropean Union was enlarged twice between 2001 and 2007. On May 1st2004 Cyprus, Czech Republic,Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia acceded to the EU. Bulgariaand Romania joined the EU on January 1st, 2007.

Accordingly, the economic environment and the protection data have largely changed between

2001 and the present time. We performed some updates to the database, in order to bring the baseline tothe year 2004 in which we added some other important agreements related with the countries understudy. We have adjusted the protection data included in the original database. This database, which wecall B2004+, includes Free Trade Agreements signed by LAC countries until 2004, as well as the

benefits accorded unilaterally by the USA to the Andean Community, the DR-CAFTA and the EuropeanUnion enlargements.

The goal of this effort to adjust the database protection structure is to seek the best possiblecoherence between this database and the registered commercial flows, so that the estimations of theimpacts of the tariff cuts reflect with the best fidelity the effects of the changes in the protectionstructure. The technical specificities used for the upgrading of the database are schematized in Figure 3which summarizes the implemented course of action to fill the gap between the years 2001 and 2004.

Following Malcolm (1998), weve used the Altertax simulation closure and parameters with thepurpose of improving the protection data by changing the LAC tariffs structure. This kind ofadjustment of the tariff rates was chosen to minimize disturbances to the data base. However, it should

be noted that the aim of this procedure is to improve the quality of the base year data (2001), whereenhanced information, such as adjustments of the tariff rates with actual data, pertaining to that baseyear, becomes available (2001). This procedure is not appropriate for incorporating information that

post-dates the base year. So, we include in the AlterTax simulation only those agreements signed andimplemented before the end of the year 2001. Appendix 4a shows the list of FTA and PTA considered inthis part of the upgrading process and Appendix 5a the average tariffs cuts.

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FIGURE 3

PROCEDURE TO UPGRADE OF THE PROTECTION DATABASE ANDLIST OF THE CONSIDERED SIMULATED SCENARIOS

Source: Authors, based on Schuschny, Durn & de Miguel, C. (2007).

In order to establish a new baseline year according with the recent liberalization agenda, we haveperformed a simulation that works as a benchmark equilibrium state. This benchmark simulation,which include many FTA and PTA signed by some LAC countries during the recent years as well as therecent EU enlargement, was implemented using the standard CGE closure and is known as GTAPB2004+ ECLAC benchmark. Appendix 4b shows the FTA and PTA included this part of the

benchmark characterization process (see also the Appendix 5b which shows the average tariffs cuts). Allother simulated scenarios that appear in this article include the same tariff shocks as the B2004+

benchmark plus the new shocks that allow us to analyze the impacts of the FTA among theMERCOSUR and the European Union.

5. Description of the simulations

Once we performed the upgrading of the original protection database by establishing the benchmarkequilibrium B2004+, we proceeded to carefully study the possible impacts of a liberalization initiative

between MERCOSUR and the EU. Weve used the General Equilibrium (GE) Standard closure in whichall prices are flexible, there is perfect competition (the firms make benefits equal to zero), fullemployment and all factors are mobiles into the countries/regions. The investment rate is determined bythe savings rate. This closure, of neoclassical style, is reached when all markets are in equilibrium. Thisis a medium term closure. Two simulations were considered:

Full: Full liberalization scenario: In this case all traded products (see appendix 2) are openedbetween EU and MERCOSUR. That is to say that their tariffs were decreased to zero.

Scenario excluding sensitive products: this scenario takes into account that some traded productsare fully opened between both blocs but there is a short list of traded goods that dont take part of theliberalization process (see Appendix 6). The sensitive products that MERCOSUR do not open are:minerals, textiles, wearing apparel, leather products, pulp and paper products, publishing, chemicals,metal products, motor vehicles and parts, machinery and equipment, electronic equipment and othermanufactures. On the other side, the EU open its economy to all tradable products excluding rice,meat and meat products, dairy products, beverages and tobacco products.

GTAP 2001

Baseline

GTAP 6.2Partially upgrade data to

year 2001

FTA and PTA among LACcountries up to December

2001

Simulation withAlterTax closure

GTAP B2004+

ECLACBenchmark

Comparative StaticScenarios:

Fullliberalization

ExcludingSensitive products

FTA and PTA among LACand EU enlargement

(December 2001-December 2007)

Standard CGEclosure simulation

Standard CGEclosure

simulation

Results outlined in the study

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III. Results analysis

All scenarios results were calculated as variations with respect to thebase scenario generated and known as B2004+. As it was explained inthe previous section this scenario already takes into accounts severalFTAs signed between 2001 and 2004 by most Latin American countries,as well as the DR-CAFTA and European Union enlargements of 2004and 2007. Thus, since the baseline year of the GTAP database is 2001,the other scenarios which will be analyzed thereafter are cleaned from

gains or losses stemming from any previous agreements. It is importantto point out that Brazil an Argentina account for more than 97% ofMERCOSURs GDP, according to B2004+data (and 97.8% accordingto CEPALSTAT data). On the other hand, EU15 accounts for 95% oftotal EU GDP so the study focuses more extensively on the effects onEU15 than on PECOS12. This sub-region has a less significant traderelationship with MERCOSUR.

The study analyzes the following economic issues: (i) themacroeconomic effects on the product level as well as the components offinal demand; (ii) the inter and intra regional trade changes; (iii) someimpacts on the productive sectors, and (iv) the effects on welfare and itsdecomposition.

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1. Macroeconomic impacts

1.1 Full liberalization scenario

In this section, we analyze the most important macroeconomic impacts of the first simulated scenario,in which the tariffs lines between MERCOSUR and the EU are fully eliminated. The FTA would have some

positive results for the two blocs. It would induce an increase of trade, both imports and exports. (SeeTable 2).

TABLE 2

MACROECONOMIC IMPACTS OF THE FULL SCENARIO

(% variation with respects to the 2004+ baseline scenario)

Consumption Investment Government Exports Imports GPDl

Bolivia(PlurinationalState of)

-0.45 -1.46 -0.50 -0.45 -1.11 -0.43

Colombia -0.04 -0.14 -0.05 -0.03 -0.12 -0.04

Ecuador -0.03 -0.13 -0.03 0.10 0.01 -0.03

Peru -0.06 -0.20 -0.08 -0.12 -0.27 -0.06Venezuela(BolivarianRepublic of)

-0.25 -0.46 -0.26 0.12 -0.15 -0.23

MERCOSUR 4.62 8.24 5.53 7.41 13.69 4.58

Argentina 0.94 2.30 0.91 2.71 5.70 0.86

Brazil 6.85 10.31 6.79 9.50 17.00 6.43

Uruguay 6.02 7.25 6.06 4.52 6.64 5.77

Paraguay 12.44 14.94 12.27 11.49 14.71 11.61

Mexico -0.16 -0.27 -0.16 -0.03 -0.12 -0.15

USA -0.14 -0.22 -0.15 -0.10 -0.25 -0.14

Canada -0.05 -0.12 -0.06 -0.05 -0.08 -0.06

Chile -0.23 -0.40 -0.29 -0.44 -0.58 -0.24

Central America -0.11 -0.21 -0.12 -0.09 -0.16 -0.11

EU27 -0.17 -0.25 -0.12 0.45 0.37 -0.15

EU15 -0.16 -0.24 -0.12 0.49 0.42 -0.14

PECOS12 -0.33 -0.36 -0.31 -0.03 -0.11 -0.31

Rest of Europe -0.13 -0.26 -0.13 -0.10 -0.17 -0.12

Ex USSR -0.09 -0.21 -0.10 -0.06 -0.13 -0.09

Emerging Asia -0.12 -0.22 -0.13 -0.06 -0.16 -0.13

Rest of Asia -0.08 -0.18 -0.09 -0.13 -0.19 -0.09

Rest of the World -0.15 -0.26 -0.16 -0.13 -0.21 -0.15

Total -0.01 -0.04 0.01 0.24 0.24 -0.02

Source: Authors, on the basis of simulations with the GTAP 6.2 model.

The MERCOSUR would benefit from this scenario. The trade growth induces a positive increaseof public and private consumption, and a greater investment demand. However, the effect onMERCOSURs trade balance is negative. At least in the short run, the region would import more than itwould export. This fact takes place for all member countries, although Brazil and Argentina, the biggestones, are not affected in the same way. Brazil is the country which increases it trade in the largest

percentage, although the effect on its trade balance is negative. Paraguay has the best performance interms of product growth so the FTA would be an opportunity to leverage its economy. In the case of

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Argentina, the significant growth of exports and investments is mitigated by the rise in imports, resultingin a less significant product level growth.

The MERCOSUR GDP increase in 4.6% with respect to the B2004+s baseline GDP. Note thatthe simulations include the loss of revenues given the tariff fall. MERCOSURs GDP growth comesmainly from the positive variations in the production price indices given by the terms of tradeimprovements (see Table 3). Even though there is also a slight positive effect deriving from quantity

variations. We observe that more than 45% of the GDP rise of these countries is explained by theconsumption growth. The other important aspect for Brazil and Argentina is the investment componentof the GDP, which accounts for 24% and 22.5% of the GDP growth of these countries, respectively.

In the case of the EU the aggregated GDP is slightly negative for the European Unionrepresenting -0.15% of the B2004+s baseline GDP. However, exports would increase more thanimports, at least for EU15. In absolute terms, exports increases are higher for EU15 countries than forMERCOSUR. This reflects the positive impact of the agreement on EUs exports to MERCOSUR. As itis expected, the rise in exports would be one of the most important reasons for the EU to sign anagreement and the simulations results keep in line with their pro-agreement advocates. It is remarkablethat the PECOS would benefit less from this agreement, all GDP components being negatively affected.This is because these new members compete with MERCOSUR in term of their trade and investmentflows from the rest of the EU.

The other countries of the Latin American region show negative impacts on their product of thisscenario. The most affected countries are Bolivia, Chile and Venezuela respectively. This can be explained

by the loss of relative preferential access to the EU and the possible trade deviation that could happen as aconsequence of the agreement. Note that Chile was the first country that signed an Economic AssociationAgreement with the EU in 2002. However, the effect on global trade would be positive, as both worldexports and imports would be increased by a 0.24% with respect to the baseline year.

1.2 Comparison with the other scenario

As it is expected, a full liberalization scenario is not a realistic set-up to analyze an FTA. Countries used toexclude or postpone the treatment of some strategic sensitive sectors in the negotiation. So they considereda set of sensitive products/sectors that should be excluded from the negotiated bilateral tariff reduction

schedule. Consequently, the tariffs for these products would remain constant. A list of sensitiveproducts/sectors was established, using the proposals established in the negotiations by the two regions in2004 (See Appendix 6). Other feasible scenarios have been discussed in the literature,5but in the absenceof concrete negotiations since the 2004 standstill, we will only consider this alternative scenario.

In this other case, the results remain positive for the trade flows for both MERCOSUR and theEU; each country increases its imports and exports (see table 4). However, as it is expected, the GDPgrowth for MERCOSUR would be lower than in the full liberalization case in all of its components.

Note that Argentina has a greater growth in this more constrained scenario than in the full liberalizationone. These results can be explain by a higher rise in consumption (which explains 64% of ArgentinasGDP increase) and a smaller relative decrease in imports than in exports as compared to the previousscenario. In this second simulation, Brazil shows results comparable to Argentina, whereas it benefitedfar more from the agreement in the first scenario. The relative reduction in Brazilian consumption and

investment explains this result, while both exports and imports grow less than in the full liberalizationsimulation. Effects on Paraguay and Uruguays products are slightly positive, but if a comparison isdone, both countries would prefer to consider the full liberalization proposal.

The impacts on the EU are quite the same as in the first scenario simulated. While sensitiveproducts are excluded, the other countries of the Latin American countries reduce their possible losses,in terms of GDP and trade with respect to the full liberalization scenario. World trade seems to besomewhat positively affected (See table 4 as well as figure 4). Just to sum up the results table 5 showsthe GDP outcome in both simulated scenarios.

5 Chaire MERCOSUR, 2006. Scenarios for a feasible Agreement.

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TABLE 3

MACROECONOMIC IMPACTS OF THE FULL LIBERALIZATION SCENARIO SCENARIO,

GDP DECOMPOSITION

(% variation with respects to the 2004+ base scenario)

Quantum Value Price

Bolivia (Plurinational State of) -0.01 -0.42 -0.42

Colombia -0.01 -0.04 -0.03

Ecuador -0.02 -0.03 -0.01

Peru -0.02 -0.06 -0.04

Venezuela (Bolivarian Republic of) -0.01 -0.24 -0.22

Argentina 0.03 0.86 0.83

Brazil 0.13 6.43 6.30

Uruguay 0.34 5.77 5.41

Paraguay 0.61 11.61 10.93

Mexico -0.02 -0.15 -0.13

USA 0.00 -0.14 -0.14

Canada 0.00 -0.06 -0.06

Chile -0.02 -0.24 -0.22Central America -0.01 -0.11 -0.10

EU15 0.07 -0.14 -0.21

PECOS12 0.01 -0.31 -0.32

Rest of Europe 0.00 -0.12 -0.12

Ex USSR -0.01 -0.09 -0.08

Emerging Asia -0.01 -0.13 -0.12

Rest of Asia 0.00 -0.09 -0.08

Rest of the World -0.01 -0.15 -0.14


TABLE 4MACROECONOMIC IMPACTS OF THE SCENARIO THAT EXCLUDES SENSITIVE PRODUCT


Consumption Investment Government Exports Imports GDP

Bolivia (PlurinationalState of)

-0.04 -0.27 -0.05 0.01 -0.15 -0.03

Colombia -0.02 -0.03 -0.03 -0.01 -0.03 -0.02

Ecuador -0.10 -0.14 -0.11 -0.02 -0.08 -0.10

Peru -0.03 -0.06 -0.04 -0.07 -0.10 -0.03

Venezuela (BolivarianRepublic of)

-0.05 -0.09 -0.06 0.03 -0.02 -0.05

MERCOSUR 1.38 1.81 1.46 1.91 2.70 1.37

Argentina 1.21 1.44 1.21 1.53 2.13 1.19

Brazil 1.55 2.00 1.57 2.10 3.04 1.51

Uruguay 0.08 0.07 0.08 0.89 0.70 0.08

Paraguay 1.80 0.96 1.78 2.51 2.42 1.70

(Continues)

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TABLE 4 (concluded)

Consumption Investment Government Exports Imports GDP

Mexico -0.03 -0.04 -0.03 0.00 -0.01 -0.03

USA -0.02 -0.03 -0.02 0.00 -0.03 -0.02

Canada -0.01 -0.02 -0.01 -0.01 -0.01 -0.01

Chile -0.04 -0.06 -0.05 -0.03 -0.05 -0.04

Central America -0.09 -0.11 -0.09 -0.05 -0.08 -0.08

EU27 -0.09 -0.07 -0.07 0.06 0.05 -0.08

EU15 -0.09 -0.07 -0.07 0.06 0.05 -0.08

PECOS12 -0.10 -0.02 -0.08 0.03 0.04 -0.09

Rest of Europe -0.04 -0.05 -0.04 -0.04 -0.05 -0.04

Ex USSR -0.03 -0.04 -0.03 -0.02 -0.03 -0.03

Emerging Asia -0.02 -0.04 -0.03 -0.01 -0.02 -0.03

Rest of Asia -0.03 -0.05 -0.03 -0.04 -0.05 -0.03

Rest of the World -0.07 -0.09 -0.07 -0.07 -0.09 -0.07

Total 0.00 -0.01 0.00 0.04 0.04 0.00


FIGURE 4

MAIN MACROECONOMIC INDICATORS OF THE TWO SCENARIOS


PIB

-2

0

2

4

6

8

10

12

14

Mercosur Argentina Brasil Uruguay Paraguay EU27 EU15 PECOS12

Full Liberalization Excluding sens itive products

(Continues)

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FIGURE 4 (concluded)

Exports

-2

0

2

4

6

8

10

12

14

Mercosur Argentina Bras il Uruguay Paraguay EU27 EU15 PECOS12

Full Liberalization Excluding sensitive products

Imports

-2

0

2

4

6

8

10

12

14

16

18

Mercosur Argentina Bras il Uruguay Paraguay EU27 EU15 PECOS12

Full Liberalization Excluding sens itive products


TABLE 5

EFFECTS ON GDP AND TRADE IN THE TWO SCENARIOS


GDP Exports Imports

FullLiberalization

Excludingsensitive

products

FullLiberalization

Excludingsensitive

products

FullLiberalization

Excludingsensitive

products

Bolivia (PlurinationalState of)

-0.43 -0.03 -0.45 0.01 -1.11 -0.15

Colombia -0.04 -0.02 -0.03 -0.01 -0.12 -0.03

Ecuador -0.03 -0.10 0.10 -0.02 0.01 -0.08

Peru -0.06 -0.03 -0.12 -0.07 -0.27 -0.10

Venezuela (BolivarianRepublic of)

-0.24 -0.05 0.12 0.03 -0.15 -0.02

(Continues)

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TABLE 5(concluded)

GDP Exports Imports

FullLiberalization

Excludingsensitiveproducts

FullLiberalization


FullLiberalization


MERCOSUR 4.58 1.37 7.41 1.91 13.69 2.70

Argentina 0.86 1.19 2.71 1.53 5.70 2.13

Brazil 6.43 1.51 9.50 2.10 17.00 3.04

Uruguay 5.77 0.08 4.52 0.89 6.64 0.70

Paraguay 11.61 1.70 11.49 2.51 14.71 2.42

Mexico -0.15 -0.03 -0.03 0.00 -0.12 -0.01

USA -0.14 -0.02 -0.10 0.00 -0.25 -0.03

Canada -0.06 -0.01 -0.05 -0.01 -0.08 -0.01

Chile -0.24 -0.04 -0.44 -0.03 -0.58 -0.05

Central America -0.11 -0.08 -0.09 -0.05 -0.16 -0.08

EU27 -0.15 -0.08 0.45 0.06 0.37 0.05

EU15 -0.14 -0.08 0.49 0.06 0.42 0.05

PECOS12 -0.31 -0.09 -0.03 0.03 -0.11 0.04

Rest of Europe -0.12 -0.04 -0.10 -0.04 -0.17 -0.05

Ex USSR -0.09 -0.03 -0.06 -0.02 -0.13 -0.03

Emerging Asia -0.13 -0.03 -0.06 -0.01 -0.16 -0.02

Rest of Asia -0.09 -0.03 -0.13 -0.04 -0.19 -0.05

Rest of the World -0.15 -0.07 -0.13 -0.07 -0.21 -0.09

Total -0.02 0.00 0.24 0.04 0.24 0.04


2. Impacts on regional trade

2.1 Full liberalization scenario

It has been shown that the full liberalization scheme between EU27 and the MEROCSUR would increasetheir imports and exports, and slightly reduce trade flows for other countries (table 5). The impacts on tradedepend on the scope of each countrys structure of trading partners relationships. According to the B2004+simulation, MERCOSURs main export destination is EU27, which accounts for 26% of its total exports,whereas intra MERCOSUR exports represent only 15% of the sub regions sales abroad. In fact, Brazil hasquite different export destinations from the other MERCOSURs partners. Its first exports destinations areEU27 and the USA, whereas MERCOSUR only represents 9% of its exports. On the other side, Argentina,Paraguay and Uruguay are more concentrated on intra-MERCOSUR trade, i.e., the first export destinationof these three countries is MERCOSUR but followed by EU27. The USA appears to be a far less important

export destination for them than for Brazil. Paraguay is the country which exports the most toMERCOSUR in percentage of its total exports.

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TABLE 6

DISTRIBUTION OF EXPORTS BY TRADING PARTNER

(Percentage of total exports, scenario B2004+)

CAN +Venezuela

MERCOSUR OthersLatAm

USA EU27 EmergingAsia

Rest of theWorld

Bolivia (Plurinational

State of) 24 21 4 16 15 6 15

Colombia 19 2 10 39 20 5 5

Ecuador 14 2 10 37 20 9 7

Peru 6 3 7 28 27 18 11

Venezuela(BolivarianRepublic of)

5 3 13 48 10 18 3

MERCOSUR 4 15 8 19 26 14 13

Argentina 4 24 12 11 21 14 14

Brazil 4 9 7 24 29 14 13

Uruguay 4 29 6 12 25 11 13

Paraguay 4 43 7 3 24 6 12

Mexico 1 1 3 78 7 5 5USA 2 3 14 0 30 25 27

Canada 0 1 2 75 11 8 4

Chile 7 7 5 17 24 23 16

Central America 2 1 11 43 23 9 11

EU27 0 1 2 11 61 10 15

EU15 0 1 2 11 60 10 15

PECOS12 0 1 1 7 74 5 12

Rest of Europe 0 1 2 13 60 11 12

Ex USSR 0 1 2 7 43 14 34

Emerging Asia 0 1 2 24 20 40 12

Rest of Asia 0 1 1 20 28 34 17

Rest of the World 0 2 1 16 37 25 19

Total 1 2 4 18 39 21 15


It is also relevant to analyze trade creation and deviation effects between trading partners, giventhe new preferential accesses and the change of costs structure. As expected, overall MERCOSURsexports to EU27 could raise in a 75.5%, from 26% more than before in Argentina to 102% in Paraguay(See Table 7). Only Argentina increases more its exports to PECOS12 than to EU15.

It is clear that intra MERCOSUR trade is negatively affected. The exports of all its members toMERCOSUR decrease, although Argentinas exports are far less reduced (-5%) than Brazilian exportsto MERCOSUR (-30%). This represents a 16% decrease in intra MERCOSUR exports, i.e. about 2.6

billion dollars. MERCOSURs exports to the rest of the world also diminish, the decrease being moreimportant for Brazil (-22.5%) than for Argentina (-3%). EU27 exports to MERCOSUR grow 66.6%, or21.3 billion dollars, a bit more than its imports from MERCOSUR (21.2 billion dollars) (see Table 8).

Note that EU27 exports could increase in more than 60% for all the MERCOSURs countries. The intraEuropean trade seems to be little affected, as well as the EU27 exports to the Rest of the World.PECOS12 also experience a sharp expansion of their exports to MERCOSUR (47.6%), and little changein their exports to other European countries and to the rest of the world.

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TABLE 7

INTRA REGIONAL EXPORTS IN THE FULL SCENARIO

(% variation with respect to scenario B2004+. Origin = line, destination = column)

MERCOSUR Argentina Brazil Uruguay Paraguay EU27 EU15 PECO

MERCOSUR -16.0 -31.6 -5.9 -17.9 -3.5 75.5 78.2 20.

Argentina -5.0 -5.6 -8.7 9.1 26.4 25.9 40.

Brazil -30.3 -32.7 -31.4 -11.5 91.4 94.8 20.

Uruguay -12.2 -24.7 -6.5 -0.9 68.9 72.3 13.

Paraguay -10.9 -21.6 -7.9 -4.3 101.7 125.3 -16.

EU27 66.6 60.3 68.2 68.6 96.9 -0.6 -0.6 -0.

EU15 67.4 61.0 68.9 69.9 97.9 -0.6 -0.6 -0.

PECOS12 47.6 46.0 48.6 34.6 63.2 -0.7 -0.8 0.


TABLE 8INTRA REGIONAL EXPORTS VARIATIONS IN THE FULL SCENARIO

(In 2001 USD millions, values with respect to scenario B2004+, Origin = rows, Destination = columns

MERCOSUR Argentina Brasil Uruguay Paraguay EU27 EU15 PEC

MERCOSUR -2598.7 -1832.4 -451.7 -270.9 -43.6 21173.6 20908.1 265.

Argentina -373.2 0.0 -350.3 -62.5 39.6 1765.6 1672.0 93.

Brasil -1965.3 -1680.8 0.0 -202.0 -82.4 18075.0 17888.4 186.

Uruguay -114.6 -79.9 -33.9 0.0 -0.8 566.8 560.5 6.

Paraguay -145.5 -71.6 -67.5 -6.4 0.0 766.1 787.2 -21.

EU27 21274.4 4637.5 15571.9 682.7 382.4 -9836.4 -9494.7 -341.

EU15 20688.3 4491.4 15150.3 670.8 375.8 -8894.3 -8533.3 -361.

PECOS12 586.1 146.1 421.6 11.8 6.6 -942.1 -961.5 19.


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2.2 Comparison when sensitive products are excluded

When sensitive products are excluded, the impacts on trade between countries have the same trend as inthe case of the full liberalization scenario, although the magnitude of the impacts is reduced.MERCOSURs exports to the EU27 would raise 20%, though in this simulation, MERCOSURs exportsto PECOS12 increase more in percentage than those to EU15 (see Table 9).

The impacts on intra MERCOSURs trade are slightly negative. In this scenario, Brazil is theMERCOSUR main country which decreases its exports to other MERCOSUR countries in percentage (-4.3%), whereas Uruguay increases its intra bloc exports by 0.5%. MERCOSURs exports to the rest ofthe world would also diminish, less for Argentina than for Brazil. EU27 exports to MERCOSUR raiseless in value (2.1 billion USD) and in percentage (6.6%) than MERCOSURs exports to the EU27 (5.6

billion dollars, or a 20% increase). As opposed to the Full scenario, PECOS12 augment their exportsto MERCOSUR more than EU27, in percentage. This is due to a major relative increase in PECOS12sexports of transport equipments and mineral products to the MERCOSUR. The intra European tradewould be little affected, as well as the EU exports to the Rest of the World (see Tables 9).

3. Impacts of the different simulations on economic sectors

In this section we analyze, at the sector level, the impacts on the production value at market price, aswell as on trade, for each of the scenarios.

3.1. Effects on the different sectors production level

The impacts of the different scenarios on economic sectors will depend on the importance of eacheconomic sector in the countrys total production. To simplify the impact analysis, we aggregated the

production structure into 5 analytical categories: (i) Agricultural products, (ii) Oil and Mining, (iii)Light manufactures, (iv)Heavy manufacturesand (v) Services. Appendix 2 shows details of the GTAPsectors included for each category.

For an easier understanding of the following analyses, let us underline that Light manufacturesencompass all food transformation sectors, which account for a significant part of MERCOSURs

production and exports. In Table 10, we represented the percentage of each of these sectors in the totalproduction for every country and bloc, on the basis of the Full liberalization simulation. BothMERCOSUR and the EU27 have an important part of the economic activity specialized in services,which account for more or less 60% of the total production value in both blocs. The importance of

Heavy manufactures is higher in the European Union production than in MERCOSUR, whereasMERCOSUR produces more Agricultural products and Light manufactures than the EU27 as a

percentage of the total production level. Within MERCOSUR, Brazil and Argentina have rather similarproduction patterns, although Brazil produces relatively more Heavy manufactures and Argentinarelatively more Services. On the other side, Uruguay and Paraguay, the two smallest economies, producecomparatively moreAgricultural productsandLight manufacturesthan their two bigger neighbors. It isimportant to notice that the baseline of the information about the structure of the MERCOSURseconomies is the year 2001, i.e. before the huge economic changes that occur after the Argentines crisis

which have also impacted on their neighbors. These changes should affect the economic structure ofthese economies.

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TABLE 9

INTRA REGIONAL EXPORTS IN THE SCENARIO INCLUDING SENSITIVE PRODUCT

(% variation with respect to scenario B2004+. Origin = line, destination = column)

MERCOSUR Argentina Brazil Uruguay Paraguay EU27 EU15 PECO

MERCOSUR -2.5 -4.1 -1.0 -4.5 -1.0 20.0 19.1 3Argentina -1.4 -1.2 -3.6 -0.3 18.6 17.8 4

Brasil -4.3 -4.4 -6.1 -1.6 21.2 20.0 4

Uruguay 0.5 0.1 0.8 0.1 4.7 3.2 2

Paraguay -1.6 -2.7 -1.3 -1.4 20.1 24.1

EU27 6.6 6.8 6.4 8.2 10.5 -0.1 -0.1

EU15 6.5 6.9 6.1 8.4 10.6 -0.1 -0.1

PECOS12 10.4 5.2 12.7 4.2 3.7 -0.1 -0.1


TABLE 10PRODUCTION VALUE AT MARKET PRICES, BY SECTOR

(% with respects to total)

MERCOSUR Argentina Brazil Uruguay Paraguay EU27

Agricultural products 6.4% 6.1% 6.0% 12.0% 19.9% 2.3%

Oil and Mining 1.8% 2.1% 1.7% 0.3% 0.1% 0.4%

Light manufactures 15.4% 15.1% 15.2% 19.0% 24.2% 10.6%

Heavy manufactures 17.1% 12.8% 19.5% 9.0% 10.0% 25.0%

Services 59.4% 63.9% 57.6% 59.7% 45.8% 61.7%

Total 100% 100% 100% 100% 100% 100%

Source: Author, on the basis of simulations with the GTAP 6.2 model (Full simulation).

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If we check the effects of the two scenarios on MERCOSUR as a whole (using Table 11), itclearly appears that theAgricultural productssector is the one which benefits most from the agreement,followed by theLight manufactures sector. The most negatively affected sector isHeavy manufactures,in both liberalization scenarios.

All sub-sectors included into Agricultural products are positively affected by either the Fullliberalization scenario or the scenario with sensitive products, with the exception of Oil seeds and Plant-

based fibers (which lose 4.2% production in the Full scenario and less in the second scenario). Thesector which benefits the most from an agreement is livestock,6whose production increases by 64% inthe Full scenario, accounting for 86% of Agricultural productsgrowth and for 26% of MERCOSURtotal production growth. This growth can be understood as the effect of increased opportunities madeavailable by the openness of European markets. It is followed by cereal grains; rice and vegetables,fruits, nuts, although gains are mitigated if we include sensitive products: the most outstanding exampleis livestock, whose production only grows by 0.5% in the second scenario, whereas the whole

Agricultural products category raises by 3.2%. Furthermore, there is one sector, Ocultivos,7 whoseproduction increases more in the scenario which excludes sensitive products.

The sectors aggregated into Light manufactures are also generally positively affected by bothscenarios. The sectors which show the highest production growth in the Full scenario are Meat

production (+87%) and Sugar (+45%). As Meat production is considered as a sensitive product by the

EU in the second scenario, its production is sharply cut (-0.5%), while Sugar production still raises(+53%). This is evident since the EU market access for Meat production should remain constant in thislatter case. The production of paper products and publishing; leather products; textiles and wood

products is reduced in the Full scenario. In the scenario excluding sensitive products, all of thesesectors but wood products are considered as sensitive products by MERCOSUR. As a consequence, theyhave a slight production increase in this second simulation.

Given MERCOSURs production structure, Servicesis the category explaining most of the globalpositive impact of the simulations on MERCOSURs production levels. However this results should beconsidered with caution since the CGE model doesnt represent accurately the service sector. Heavymanufacturesexplicates most of the negative impact on MERCOSURs production. Each sector of thiscategory shows negative results, the most negatively affected in the Full liberalization scenario wasmachinery and equipments (-16%); metals (-13%); and transport equipments (-11%). The exclusion of

machinery and equipments and metals as MERCOSURs sensitive products reduces the losses in thesecond scenario. It is important to consider that these are strategic sectors with the highest value addedover the economy so as the bloc would be worried about open them up and loose their competitiveness.

As we saw, the two scenarios do not necessarily implicate the same distribution of positive andnegative effects among the five categories of sectors under consideration. Public sectoral policies shouldtake into consideration the discrepancies between sectors and the possible resulting economic and socialimpacts.

On the basis of Table 11, a similar analysis by category is conducted for each MERCOSURcountry, as follows:

6 Which includes various GTAP sectors: ctl (Cattle, sheep, goats, horses), oap (Animal products nec), wol (Wool, silk-worm cocoons),rmk (Raw milk)

7 Which inc

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